Pennies From Heaven

By

Andrew Bary

Updated Jan. 11, 1999 12:01 a.m. ET

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M any a profitable business has been founded on the principle of doing tasks for people who are too lazy to do things for themselves: lawn care, car-washing and house-cleaning come immediately to mind. Well, here's another little-known example: a former research analyst with Morgan Stanley has started an enterprise to help Americans cash in all those jars of loose change hiding in our dresser drawers, kitchen cabinets and coat pockets. The business is called
Coinstar
, and its founder and chief executive is Jens Molbak, 36. Like other successful service companies, Coinstar aims to make money by charging its customers a pretty penny, if you'll forgive the pun. For every dollar of change that's collected by Coinstar's machines, Molbak takes 8.9 cents. After several years in operation, Coinstar now has 4,800 of its self-service coin-counters up and running, exclusively in supermarkets such as
Kroger
,
Fred Meyer
and A&P.

Wall Street so far has been lukewarm on Coinstar. The company's shares trade around 10, slightly below the price of $10.50 set at the company's initial public offering in July 1997. Yet some folks think Coinstar has a winning concept and predict the shares could double over the next year.

"Coinstar resembles the cable TV industry," says Curt Alexander, an analyst with Media Group Research in Sudbury, Massachusetts. "It has a terrific business model. It effectively has a monopoly. Its revenues aren't economically sensitive, and its cash flow is growing."

One reason for Alexander's bullish view: Coinstar recently raised its fee to 8.9% from 7.5%, suggesting that the company has pricing power and that consumers aren't averse to the increase. Coinstar, Alexander notes, has no sizable competitors. Supermarkets like Coinstar because it doesn't pay its customers money but instead gives them vouchers that can be redeemed for either groceries or cash. About 70% of Coinstar's customers use the receipts to buy groceries.

"We're creating found money for people," says Molbak. "Most people don't realize how much change they have lying around their houses. We call it America's hidden savings."

By Molbak's estimate, Americans are sitting on $7 billion in coins, or about $60 per household. That cash hoard provides just one opportunity for the company, which so far has redeemed over $1 billion in coins. The other opportunity arises from the $8 billion in coins that circulate each year. Molbak maintains the average American adult handles $600 in coins annually.

Molbak admits that many investors wonder "how a company can make money from pennies." And there are large numbers of Americans, particularly those who remember when a penny actually could buy something, who recoil at the notion of paying a fee to have their change redeemed. But this is an age of convenience. For many people, time has become more precious than money.

To those who think Coinstar's fee is a rip-off, Molbak points out that it can take someone 40 minutes to roll $9 worth of pennies. The same transaction lasts just 90 seconds at a Coinstar machine, and it costs less than $1. Ever the salesman, Molbak asks, "Is your time worth more than $1 or $2 an hour?"

Some people sort coins using those machines that are advertised on TV for $25 each. But you would have to cash in more than $280 in coins to make the use of those machines cheaper than using the Coinstar system.

From an investment standpoint, Coinstar carries risk because the company has posted losses since its inception, it isn't expect to turn a profit until the year 2000, and it carries an ample debt load -- $85 million. Hardly any analyst on Wall Street covers the company. One reason is that it has a small market value of $150 million. Another is the lackluster showing of its stock since its IPO.

Alexander argues that investors should look beyond Coinstar's reported losses, which have reflected the company's aggressive national expansion over the past three years. He says Coinstar should be evaluated based on its cash flow, like the cable industry. He notes that its revenues have risen from $1 million in 1995 to an estimated $46 million in 1998, and it could hit $82 million this year. Coinstar's cash flow, a pretax measure that adds back depreciation and doesn't include interest expense, turned positive for the first time in the third quarter. Cash flow could reach $22 million this year and $40 million in 2000, Alexander predicts.

By the end of this year, Alexander sees Coinstar shares hitting 20, which is 10 times estimated cash flow for the year 2000. Alexander recently raised his cashflow estimates for 1999 and 2000 because of the aforementioned fee hike, to 8.9% from 7.5%, in December. Molbak won't comment on fourth-quarter 1998 results, which are due to be reported on February 2, other than to say that "the business continues to exceed our expectations."

Coinstar could have plenty of growth potential given that it now has machines in fewer than one-third of the 15,000 big supermarkets in the largest 100 markets in the U.S. Molbak has chosen to ally with supermarkets because of the high traffic they generate. Coinstar gives the big chains about a penny for every dollar of coins it cashes, making the Coinstar machines among the highest profit areas in the stores on a per-square-foot basis. The supermarkets also feel the coin machines boost their sales. The average coin redemption is $30, making consumers feel richer and more inclined to splurge on groceries.

Coinstar now has agreements with all the major supermarket chains in the country except for three:
Safeway
,
Albertson's
and
Publix
. Yet Safeway and Albertson's now are testing Coinstar machines in some of their stores. If their experience is as favorable as other chains, they could ink deals with Coinstar this year.

"The Coinstar machines have been a win-win for us," says Nick Fronduto, director of store operations for Star Markets, a Massachusetts supermarket chain that has machines in all of its 53 stores. "The customers love it, and we've been very pleased."

Fronduto admits that he initially was "skeptical" about the idea when the machines were rolled into Star Markets in 1996. "We thought that after an initial surge, volumes would fall off, but nothing could be further from the truth." Fronduto says usage has steadily risen. "We've become a destination point for people who want to redeem their change." Waiters and waitresses, for example, regularly use the Coinstar machines to redeem all the coins they get as tips. Fronduto says the machines break down infrequently and get fixed quickly when they do.

Molbak, a Seattle native, got the idea for Coinstar while a graduate student at Stanford in the late 1980s, after spending two years as a junior analyst at Morgan Stanley: "I saw all the change that I and my friends had accumulated and decided to turn a problem into an opportunity." Getting financing wasn't easy because many venture capitalists thought Molbak's idea wouldn't work. But he got enough money to produce the first machines in 1993, sold junk bonds in 1996 and offered three million shares in his 1997 stock offering.

Coinstar's machines don't look fancy, but they employ some patented technology that allows them to process 600 coins a minute. They also identify and reject slugs and other foreign objects, clean and sort the change, and relay the machine's ongoing take to company headquarters via an internal computer.

The Coinstar machines now generate an average of $3,200 a week in coin redemptions. Usage, Molbak points out, rises with time. Pennies account for about three-quarters of the redeemed coins, which are stored in two 500-pound capacity drums inside the machines.

Coinstar used to use armored cars for all its pickups, but now it is contracting out some of the work to private trucking companies, at a much lower cost. The reason: Who's going to steal 1,000 pounds of change and try to run away? Molbak is sometimes amused by the kinds of debris that gets filtered out by the machines: "We get paper clips, nuts, bolts, dentures, wedding rings. In Silicon Valley, we see capacitors and resistors, and in some places we've even found bullets. It tells you a lot about the area when you see what debris we get."

Molbak says his four original Coinstar machines in San Francisco are still among the top-producing ones in the company's system. But the highest-volume machine is in the capital of convenience, Manhattan, where many residents live with jars of change in cramped apartments because they don't want to deal with the hassle of redeeming coins at banks.

One Manhattan Food Emporium store is generating about $20,000 a week in volume. The New York region boasts seven of the 20 top-grossing machines in the Coinstar network. Other strong markets include Dallas, San Francisco, Phoenix and Atlanta.

Coinstar boasts that it now recirculates more coins than the U.S. Mint produces each year. Indeed, the government is happy that Coinstar is helping bring coins back into circulation and thus reducing the need to mint more money.

Alexander says one reason Coinstar has posted losses is that it wanted to move quickly to blanket the country with its machines. Profits should materialize as the company is able to spread its fixed costs, for administration and the like, over its ever-expanding base of machines. Another hopeful sign: Alexander notes that Coinstar's accountants write down the value of the machines, which cost around $12,000, over five years, while they could actually last as long as 15 years.

The company recently began TV ad campaigns in selected markets, featuring an organ grinder and monkey with a tag line, "Change your Change." Molbak says the campaign has been successful in increasing consumer awareness and driving higher volumes.

"Our research shows that only 6% of people even know we exist," Molbak says. "But once people use the service, we have about an 80% retention rate." Repeat users tend to be more profitable because they deposit fewer pennies.

Coinstar may not be minting money now, but the trends look favorable and the market opportunity seems large. Competition will eventually come. But Molbak has quietly carved himself out an impressive niche. Before long, his wacky idea may prove to be a real winner.

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